SHANGHAI/SEATTLE (Reuters) - In his first official visit to
the United States in 2006, China President Hu Jintao arrived
for dinner at Microsoft Corp. <MSFT.O> Chairman Bill Gates'
house with a gift for the host.

Shortly before Hu's Seattle visit, the Chinese government
had issued a decree requiring all personal computers
manufactured in China to come with a licensed operating system
before leaving the factory gates.

Now, nearly two years later, that gift keeps giving. The
software company co-founded by Gates is seeing the benefits of
more stringent intellectual property policies in China, with a
decline in piracy rates and improved results at its mainstay
Windows division.

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China is by no means the worst offender.

More than a dozen other countries -- including Indonesia
and Ukraine -- have higher software piracy rates, according to
a study from the Business Software Alliance and IDC. None of
those countries, however, offers the promise of China, the
world's second-largest PC market, growing at more than 10
percent a year.

China's piracy rates, the level of pirated software in a
particular country, dropped to 82 percent in 2006 from 90
percent in 2004, the study said.

"In China, where piracy is the way things are done with
respect to software, any marginal money Microsoft gets back is
super important," said Kim Caughey, portfolio manager and
senior analyst at Fort Pitt Capital Group.

Reducing software piracy and selling more expensive
versions of Windows are ways for Microsoft to generate sales
growth that exceeds the overall PC market, a task made
difficult since its global market share already tops 90
percent.

Microsoft said improvements in fighting piracy accounted
for about $164 million of the $822 million revenue gain at the
Windows client unit in the quarter ended September.

Windows is Microsoft's most lucrative product with an
operating margin exceeding 80 percent.

"Every pirated copy that Microsoft converts into a paying
customer all flows to the bottom line," said Morningstar
analyst Toan Tran. "It could have a dramatic effect on its
profit margin."

PIRATES AT WORK

Despite the progress being made, pirated software is still
readily available on the streets of Shanghai.

Fuzhou Road in the former British concession near the Bund,
an area famous for bookstores and art boutiques, is also
locally renowned as a place to buy pirate PCs and software.

The small alleyways running off Fuzhou Road host dozens of
pirate PC shops, which usually have no signs. Locals ask
passersby if they want to buy "cheap" PCs or software before
leading potential customers to the store.

Once a computer is assembled, the customer is given a list
of pirated software options, ranging from Microsoft Office to
Adobe Systems' <ADBE.O> Photoshop. If a software program is not
there, it can be ordered.

The government decree requiring PC makers to pre-install an
operating system sought to address the problem of Chinese
consumers buying computers without software and then opting to
buy less expensive counterfeit software.

Beijing went one step further, calling on any Chinese
companies wanting to do business with the government to run
properly licensed software.

"The whole situation is heading in the right direction,"
said Hao Jing, spokeswoman at Founder Technology Group
<600601.SS>, China's second-largest PC maker. "Pre-installing
genuine copyrighted operating systems has become an industry
standard."

Earlier this year, the Chinese police and the U.S. Federal
Bureau of Investigation seized $500 million worth of pirated
software, including counterfeit Microsoft and Symantec <SYMC.O>
products, from a Chinese piracy syndicate.

"We've seen in the last two years significant emphasis on
legitimate intellectual property use in China," said Cori
Hartje, director of Microsoft's genuine software initiative.

Microsoft said it needs to do more in educating consumers
to the benefits of getting genuine software like access to
software updates and better security. Improved technology also
serves to deter piracy.

Windows Vista, the latest version of its operating system,
has been more effective in preventing piracy. Microsoft has
said piracy rates for Vista are half the level of its
predecessor Windows XP.

In Vista's first major update due out next year, Microsoft
said it plans to close two primary methods used by software
pirates to illegally copy Windows Vista.